Pension management needs to set realistic discount rates

Setting realistic discount rates for calculating future liabilities is fundamental to creating healthier public pension systems, but the price tag will be high, according to recommendations from the Rockefeller Institute of Government.

Changing the way the discount rate is set to reflect the riskiness of expected benefits payments would likely cause a $2 trillion rise in reported liabilities for state and local retirement systems across the U.S., the institute, a part of the State University of New York, said.

By valuing liabilities at a rate that assumes no risk, the institute said taxpayers would have a better idea of the state of the pension funds. Such a discount rate would raise the annual total bill for governments to fully fund their systems by $100 billion. The institute cautions that that figure would be lessened or increased depending on how well riskier investments did in a given year.

While the costs would be high, the institute said, “the alternative is to continue blithely, ignoring risk, simply hoping things will turn out well …”

Public pension reform has been a hot topic across the nation as budgets have come under increasing pressure because of required contributions to retirement funds.

The institute noted that reforms aimed at reducing pension benefits have been met by legal challenges from workers who argue they won their pensions through collective bargaining and changes can only be made through negotiation.

“The bottom line,” the institute said, “is that governments that find themselves in deep distress due to underfunded pensions appear to have quite limited options to reduce already accrued liabilities.”

In all, the institute made five recommendations. The other four were:

Investment Consequences: The Actuarial Standards Board should develop standards about disclosing the potential investment consequences on contribution levels from governments.

Investment Risk: Pension boards need to develop formal statements of the amount of risk they are willing to take. The statements should be considered “explicitly as they develop” their investment and allocation policies.

Contributions: “governments should keep their end of the bargain and pay realistic actuarially determined contributions.” The institute noted that several states require local governments to do this, but it more rare for them to mandate such behavior for themselves.

Federal Help: The U.S. government should consider ways to improve the health of state and local pension systems by increasing regulatory oversight and transparency.

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